February 11, 2021

Roth Conversions = Smart Tax Planning, Ep #32

18 minutes

You can’t control health insurance premiums going up. You can’t control rising prescription costs. But you can control your tax planning. As the old saying goes, “You have to make hay while the sun is shining.” We are still under the 2017 Tax Cuts and Jobs Act. Until that changes, the sun is shining and you should consider taking advantage of a Roth conversion. What is it? How does it help you? Listen to this episode of Retirement Made Easy to learn more!

You will want to hear this episode if you are interested in...

[3:09] What is a Roth conversion?
[4:52] The 2017 Tax Cuts and Jobs Act
[6:19] Comparing taxes from 2010 to 2020
[9:02] Forced IRA/401k distributions
[10:23] How much should you convert?
[13:10] When do you do a Roth conversion?

What is a Roth conversion?

A Roth conversion is biting the bullet and paying taxes now while the US is in a low tax environment. A simple IRA is a pre-tax, tax-deferred retirement account. If you want to convert $10,000 of your IRA or 401k, you’re choosing to pay the taxes now instead of in retirement. You can then take the money you converted and add it to an existing Roth IRA or open a new one.

The beauty of the ROTH IRA is that it grows tax free for the rest of your life. You don’t have to convert your entire account. If your IRA is holding $100,000, you don’t have to convert it all in one year. You can convert it in bite-sized chunks. Maybe you convert $10,000 this year and $20,000 next year. The idea is to pay taxes now while they’re low.

The 2017 Tax Cuts and Jobs Act

In 2017, the Trump Tax Bill was passed. It lowered tax rates for individuals and corporations. The majority of Americans saw a reduction in their yearly taxes and the standard deduction increased significantly. Bill Bischoff wrote an article entitled “Two years after the Tax Cuts and Jobs Act — who are the winners and the losers?”

Bill quoted a study done by the tax policy center that found that 65% of households got a tax cut in 2018. For households with incomes $100,000 or more, 89.5% saw a reduction in their income taxes. Oddly enough, only 46% of the households making $100,000 thought they were getting a reduction in their taxes.

Comparing taxes from 2010 to 2020

If you were in a household that was making $250,000 in 2010, the federal income tax would’ve been $60,281. In 2020, the federal tax bill would only be $48,159. That’s a $12,000 tax savings 10 years later.

This current tax environment is set to sunset at the end of 2025. If no changes are made, it will revert back to the previous plan at the end of 2025. However, with a new presidential administration, taxes will likely increase. It would have to be approved by congress. Many are speculating that we won’t see higher taxes until 2022 or 2023.

How much money should you convert?

What is your earned income from a W-2 or 1099? What about dividends or social security? Are you close to topping out your current tax bracket? If you’re in the middle of the 12% tax bracket, we can help you determine how much you can convert. Let’s say $18,500 maxes you out of the bracket. So we’d convert that amount and not a dollar more. Why? If you do more, you’ll get pushed into the next tax bracket—22%.

It's forward thinking tax-planning. You are paying your financial advisor to help you make the most of the tax policies you’re currently under. It’s making smart choices. Many people who are now retired are finding themselves paying higher taxes than they did their entire life. We don’t know what the tax-rate environment will be like in the future—but we know where it is now. Dive deeper and work with your financial advisor to see if Roth conversions make sense for you.

When should you do a Roth conversion? I share the best way to make that decision, so listen to the whole episode!

Resources & People Mentioned